• 11 Mar 19
  • Posted by Johnson, Ricardo
  • 0 Comments

Trade liberalization: the need for complementary domestic policies

Trade liberalization can significantly increase the prosperity of people in developing countries like Mexico. But as this column explains, to reap the potential benefits of the United States-Mexico-Canada Agreement (USMCA), the Mexican government must use complementary domestic policies, including investment in infrastructure and efforts to tackle corruption.

Theoretical analysis and empirical studies provide ample evidence of the gains from trade. The Organization for Economic Co-operation and Development (OECD) finds that relatively open economies grow faster than those that are relatively closed. Evidence also suggests that salaries and working conditions tend to improve in countries that engage in trade.

What’s more, regions within countries that have the biggest increases in productivity have a growing share of their economies devoted to tradable sectors. Generally speaking, higher productivity levels result in economic growth, which in turn can help people escape from poverty.

Most importantly, trade liberalization can bring about tangible benefits to society in the form of improved resource allocation, access to better technologies, inputs and intermediate goods, and improved domestic competition.

Yet despite its purported benefits, in many cases increased trade has had a limited effect in terms of stimulating economic growth. For example, Mexico has pursued open trade policies for several decades, but has not experienced the substantial growth that was expected.

While it is true that certain sectors within emerging markets have become more competitive and wealthier, the overall benefits of trade liberalization have fallen short. This is mainly because the benefits of trade do not occur in an economic vacuum, but are tightly linked to a country’s domestic policies.

It should also be noted that the gains from trade are expressed in net terms, which means that the ‘winners’ gain more from trade than is lost by the ‘losers’. But the losers have more incentive to make their voices heard in the democratic debate—and they have often been louder in recent years.

In Mexico, the North American Free Trade Agreement (NAFTA) has not lived up to its potential for delivering sustained economic growth and poverty reduction. In fact, the Mexican economy has grown at a slower pace than the rest of Latin America since the agreement came into effect in 1993. According to El Economista, between 2000 and 2016, Mexico’s per capita GDP grew by 1% per year, while that of Latin America as a whole grew by 1.5% per year. Forbes magazine estimates that in 2016, nearly 44% of the Mexican population lived in poverty.

Mexico’s economic stagnation and high poverty rates can largely be attributed to the government’s failure to introduce desperately needed structural reforms alongside its trade policy. There has also been lackluster support for those who are adversely affected by trade. With the implementation of a fresh United States-Mexico-Canada Agreement (USMCA) around the corner, Mexico should finally look at trade and domestic policies as interdependent issues.

Philip Sauré establishes a relationship between trade agreements and domestic policies. Because domestic policies dictate local economic conditions, failing to consider them can undermine the intended objectives of even the most ambitious trade agreement. Such policies might include measures to encourage competition, to bring the gains of trade to more people, and to combat corruption.

Mexico has to develop its capacity to realize the benefits of trade and distribute these efficiently to as many people as possible. Meaningful reforms are needed to address market inefficiencies and monopolies in domestic industries, particularly in the communications and energy sectors. These distort prices for consumers, generate inefficiency, and create uneven playing fields. This, in turn, limits economic productivity and prevents stronger growth.

The country also needs to do a better job of investing in infrastructure so that all regions have the capacity to participate and benefit from trade. Marcela González Rivas finds that infrastructure is necessary to stimulate economic development, and uses these findings to explain why the poor performance of Mexico’s southern states post-NAFTA is due in large part to policy decisions that neglected the development of proper infrastructure. States such as Chiapas, Oaxaca, and Guerrero lack basic roads, ports, hospitals, and schools. Without proper infrastructure, these areas will remain marginalized from the rest of the national economy.

Mexico should also ensure that labor markets and social safety nets are working effectively, and that all members of society are able to participate in the opportunities created by trade. Although the generation of employment is important, it is not enough. The OECD, for example, argues that inclusiveness is also about empowerment and voice, not just about jobs and income.

Specific policy actions here include ensuring greater access to good quality health and education, especially for the poorest people. They also include implementing effective frameworks for encouraging more people into the labor force—for example, tax incentives aimed at decreasing the size of the informal sector.

As with NAFTA, Mexico will find it difficult to realize the gains from trade under USMCA without policies that root out corruption and reduce violence. The costs of corruption represent between 2% and 10% of the country’s GDP every year. The government can start to get serious about fighting corruption by implementing a national anti-corruption system that is transparent and enforceable, which includes the designation of an independent attorney general.

Mexico should learn from its experience with NAFTA to ensure that the same mistakes are not repeated. This means considering policy alternatives that can be implemented alongside USMCA to improve results and benefits. Trade policy can significantly increase the prosperity of the Mexican people should the government decide to use complementary domestic policies along with it.

 

Author:

Ricardo Johnson is an economist specializing in Latin American trade and investment. He worked as a Trade Negotiator for the Mexican Tax Administration Service during the renegotiation of NAFTA.